Behind Woolies’ $10b liquor sale

Brad Banducci is betting his career that he must disrupt Woolworths in an even more brutal way, or watch its hollowed-out earnings fall further.

Jul 3, 2019

AFR

In a bizarre way it could be argued that the least interesting part of Woolworths’ grand plan to split itself in two is the fact it will create a new $10 billion ASX giant.

Instead, it is what this deal says about the future model of retailing in this country that could reverberate through the economy – if Brad Banducci’s bold vision actually comes to pass.

Woolworths chief Brad Banducci has unveiled a bold plan to drive growth.  Illustration: David Rowe

Beneath the excitement that will be generated by the creation of Endeavour Drinks – which will have $10 billion in annual sales and house the ALH pub group and the Dan Murphy’s and BWS chains – Banducci has devised a plan that promises to turn Woolworths into a platform that could partner with other businesses looking to access its supply chain power, its store network, its data and analytics business and even its payroll services.

It’s the sort of vision that a consultant salivates over – devised by a man who spent a big chunk of his career at Boston Consulting Group. There are no guarantees it works in a meaningful way in the real world.

But Banducci is betting his career that he must disrupt Woolworths in an even more brutal way, or watch earnings in its supermarket business, which have been sharply rebased over the past five years, fall even further.

The obvious conclusion to draw from the demerger is that Banducci has finally found a way to rid himself of the problematic poker machine  business housed inside the ALH pub group.

It’s been a thorn in the side of Banducci and previous chief executives for some years and the ever-mounting focus on ESG (environmental, social and governance) issues from big super fund investors means he had to act sooner or later. Woolworths’ partner in the ALH business, Melbourne pub baron Bruce Mathieson, is right behind the deal and will have 14.6 per cent of Endeavour.

But the Woolworths camp insists ESG problems are low down the list of priorities in this deal, given gaming machines account for just 7 per cent of revenue.

More pressure

The biggest issue is that cited by Wesfarmers in its splitting off of  Coles: Capital allocation.

Supermarkets are capital hungry at the best of times, but changing customer demands are only putting more pressure on the purse strings.

Online shopping requires stores to look and work differently, and supply chains to be restructured. But a dollar of sales online is somewhere between barely profitable and loss-making, which means Woolworths and Coles need to pump money into labour-saving technology to try to change the economics.

The cost/investment squeeze is not going away anytime soon and this has left the drinks business struggling to win the capital that it needs to change its business, too.

Don’t forget, too, that Banducci has called out in recent results the challenging trends in liquor retailing, and put the Dan Murphy’s business into a strategic review process earlier in the year.

The broad trend in Australia has been towards consumers drinking less but better quality booze.

But even the dominant Dan Murphy’s chain has struggled in recent periods, as weaker discretionary spending has collided with a need to boost investments in range, service and convenience, including better meeting the needs of online customers.

Woolworths will still work with Endeavour in a partnership, but all in all, you can understand Banducci’s demerger logic.

Important ESG win

This does look like a good time for Woolworths to split off the drinks business before its market position erodes any further, and its capital requirements increase.

Getting rid of the pub business, one intertwined with liquor retailing, given 30 per cent of Dan Murphy’s and BWS stores are actually owned by ALH,  is an important ESG win.

The other side of this equation is, of course, what’s left at Woolworths, which will have annual sales of $47.1 billion and earnings before interest and tax of $1.8 billon.

The rump of the business is, of course, the 1200 supermarkets it operates in Australia and New Zealand, plus the soon-to-be-shrunk network of Big W discount department stores.

Focusing more tightly on this food business should allow Banducci to better defend the market position of his supermarket business against not only Coles and Aldi, but  the arrival of Germany’s Kaufland and the potential ramp-up of Amazon’s local offer.

Remember that Coles chief Steve Cain has set himself the modest goal of expanding in line with the market, which underscores just how hard the market’s dominant duo are going to have to work to stand still.

While Banducci insisted on Wednesday that Woolies had got it wrong a few years ago when it believed the food business would stop growing, his plan to turn Woolworths into a platform recognises that he will need to look outside the square for growth.

The essence of the plan is that Woolworths has built five key planks that will allow it to generate earnings by partnering with other groups.

Loyalty program

The first area is rewards and payments, where it operates a loyalty program that has about 14 million members, and its own digital platform payments, which operates through its Woolies X digital business.

The second plank is media and data analytics, via the Quantium data business it purchased in 2013, and its new media sales business called Cartology, which allows suppliers and partners to communicate with Woolworths customers in stores and via email.

The third plank is supply chain and property development. Woolworths subsidiary Primary Connect is perched on the retailer’s own giant supply chain structure, and is already offering logistics services to third parties. Banducci said on Wednesday the business is already profitable.

The fourth and fifth planks look the most marginal.

Banducci believes Woolworths could offer IT infrastructure, applications and support through Woolies X and even sees an opportunity around what he calls people and transaction services – essentially selling Woolies’ payroll, transaction and safety services outside the business.

Banducci and his team have a few inspirations for their ecosystem plan, most notably Amazon – where Banducci says revenue from media sales business will eclipse its web services business in the next few years – and US supermarket chain Kroger.

A recent Kroger presentation shows its plan to grow “alternative profit streams” particularly from a media business called Kroger Precision Marketing. Revenue grew 150 per cent last year and it is part of Kroger’s plan to add $US400 million of incremental earnings in 2019 and 2020.

Banducci says the size of these ancillary businesses may not be huge, but they will attract much better margin than grocery retailing, which he rightly describes as “an inherently low growth business”.

Meaningful growth

“They will not have large revenue numbers associated with them, but they can be very profitable.”

He has run something of a test case for this platform theory in the sale of Woolworths’ petrol business, whereby he sold his fuel business to Caltex under a deal whereby he can still provide a discount program to Woolworths customers, and retain the petrol network as part of the Woolworths Reward loyalty program.

Similarly, Endeavour Group will use many of these platforms after it is demerged – and pay for that privilege.

Still, driving meaningful growth of the sort that actually moves the dial for investors will be no simple task. Woolies shares closed up 2.7 per cent on Wednesday at $33.82, so the excitement was muted – although the stock remains close to its recent high of $34.82.

There’s some irony in the fact that while Banducci’s plan will help simplify the food business, he’s arguably pushing into four or five areas that look pretty complicated to execute.

Banducci hasn’t necessarily answered the question of where future growth is coming from in the supermarket sector. But his big plan to slim Woolies down at least gives it a better chance to work that out.